BUSINESS

MARKET POLITICS

CANADA’S MARKETS GET EDGY AS THE ELECTION CAMPAIGN BEGINS

BRENDA DALGLISH September 20 1993
BUSINESS

MARKET POLITICS

CANADA’S MARKETS GET EDGY AS THE ELECTION CAMPAIGN BEGINS

BRENDA DALGLISH September 20 1993

MARKET POLITICS

CANADA’S MARKETS GET EDGY AS THE ELECTION CAMPAIGN BEGINS

BUSINESS

As the long-awaited federal election campaign began last week, Bay Street’s powerful financial institutions quickly joined the nation’s political parties in hiring pollsters to probe the collective psyche of Canadians. Major banks and investment dealers have signed up to receive daily reports on how Canadians plan to vote. “There’s a lot of uncertainty about this election,” said Sherry Cooper, chief economist at Bums Fry Ltd. in Toronto, “and our clients around the world want to be kept informed.” Environics Research Group Ltd. of Toronto, one of the polling companies offering its services to Bay Street, will survey 200 Canadians daily to find out how their intentions change during the sixweek election campaign. Citing a surprising Gallup poll during the last federal election that incorrectly indicated a Liberal win—and triggered a drop in the value of the dollar— Donna Dasko, an Environics vice-president, said: “After that ‘rogue’ poll, the financial community began to realize that polls can have consequences and that it pays to keep on top of them.”

Bay Street’s obsession with election polls is a sign of just how sensitive the markets are in this election. One reason for that edginess is the high level of Canadian debt held by foreign investors, who would be quick to pull out if government policies became less attractive for their purposes. Foreigners now hold $195 billion worth of Canadian government debt, or 37 per cent of the total, up from about $111 billion, or 29 per cent, in 1988. “Markets get to vote, too,” said the head of one foreign bond trading company. ‘They vote by walking away from the market. And their vote in 1993 is substantially bigger than it was in 1988.” In addition, the outcome of this election is even more uncertain, as five parties fight for seats and the Tories and Liberals enter the campaign virtually tied in the polls. Some market watchers hold the political climate partially responsible for the Toronto Stock Exchange’s two-day plunge last week. Political uncertainty, combined with doubts about Canada’s economic recovery, create nervousness and encourage investors to stay on the sidelines. “We’ll be very pleased to see the election out of the way,” said Paul Thursby, a senior portfolio manager

with Baring International in London. “There are a lot of reasons to be worried.”

By nature, the financial community tends to advocate reduced government borrowing and less intervention in the economy. As a result, Bay Street favors a Tory majority government with a strong mandate to cut the deficit. Few institutions, however, are likely to take a high-profile role in the Tory campaign for fear of inciting a public backlash against what is perceived as the corporate

agenda—the same sort of antiestablishment movement that helped defeat the Yes side in last fall’s constitutional referendum. The irony is that the financial sector, while continually harping about the dangers of heaving government borrowing, is also one of the groups that benefits most directly from public debt. By acting as middlemen in raising billions of dollars each year from foreign and domestic investors, financial institutions collect millions of dollars in fees.

While Bay Streeters have been critical of some aspects of the Conservative party’s performance since it took power in 1984, they do not view the other parties as attractive alternatives. In fact, the Liberals have been provoking controversy in Canadian financial circles because Jean Chrétien has indicated that he might not reappoint John Crow, governor of the Bank of Canada, when his term expires at the end of January, 1994. Most recently, in an interview with The Globe & Mail, Chrétien suggested that, if he forms the next government, he would issue instructions to the bank. That left open the possibility that he might order Crow to

do something Crow disagreed with and provoke his resignation.

That threat to the bank’s traditional independence quickly became the talk of Bay Street. Crow is frequently lauded in international financial circles for his determined fight against inflation. While some critics claim that his policies deepened and extended Canada’s economic recession, the policies are also the reason Canadian interest rates are now at their lowest level in more than 20 years. Said Bob Sinche, a fund manager at Alliance Capital Management Ltd. in New York City: “Mr. Chrétien has made it clear on a number of occasions that the Bank of Canada is an issue for him. It’s a very shortsighted position because Mr. Crow has terrific credibility internationally as an effective central banker. Why would Mr. Chrétien want to lose that?” Added Bums Fry’s Sherry Cooper: “There is no need for Mr. Chrétien to take on John Crow or threaten his perceived independence. Though it may play well at home, it runs the risk of destabilizing markets and therefore the economy.” Subsequently, Paul Martin, the Liberal associate finance critic and coauthor of the party’s policy platform statement (which is scheduled for release this week), attempted to clarify the party’s stance. ‘Two years ago, we were calling for a monetary policy similar to the bank’s policy now,” Martin told Maclean’s last week. “We believe that if the government and the bank had followed our views a year and a half ago, we would not have the painfully high level of unemployment that we have now.” But, he noted: “Today we are satisfied that the basic policy of the bank in the past six months has been correct.” But Sinche, whose firm manages about $132 billion—including $1.3 billion now invested in Canada—says that he is unimpressed with that explanation. “Give me a break,” he said. “If they’re satisfied with it, why does Chrétien keep talking about it?”

The fate of the Bank of Canada’s monetary policy is commonly identified on Bay Street as the single issue that could do the most damage to financial markets during this election. “Luckily, the [Chrétien] comments came at a time when the markets in Europe and the United States were on holiday,” said a bond trader, who spoke on the condition of anonymity.

He added that if the Liberals appear poised to win the election—and if they persist with policy statements that appear to threaten the central bank’s traditional independence—interest rates would likely start to climb. In theory, they would have to rise enough to de ter foreign investors, who are fearful of having their investments devalued by inflation or a falling dollar, from dumping their bonds and currency holdings. But back home, higher interest rates could stamp out the fragile economic recovery now taking place.

But Crow’s monetary policy is not the only issue that financial markets will be watching carefully. Leo de Bever, chief economist at Nomura Canada Inc., the Toronto-based office of the Japanese securities firm, said that anything from the federal deficit to Quebec’s separation could blow up and spook foreign investors. “They’re sort of a hidden participant in this election,” said de Bever. So far, however, the international financial community has not been paying excessive attention to Canada. “My sense is that the prevailing wisdom among foreign investors is that the Tories will win a majority,” said de Bever, who counsels a variety of Japanese investors. If the Tories lose, however, de Bever says that the market might react badly. Citing the example of a fairly typical fund manager in Tokyo with a $ 100-billion portfolio, including $2 billion in Canada, he noted: “It takes a certain event or a set of events to bring Canadian issues into focus for that manager. An election is that kind of event.”

De Bever speculated, for example, that photographs of a large, enthusiastic Bloc Québécois demonstration calling for the separation of Quebec could surprise foreign investors and cause them to draw back from the Canadian markets. In addition, he said that many foreign portfolio managers now have a larger than normal proportion of their investments in Canada because they have been optimistic about Canada’s near-term economic potential, giving them an another reason to sell if they decide that the economic environment is changing for the worse. “It’s scary to think about because in the short run it could get nasty,” he said. “But, on the other hand, we Canadians have made these periods of political turmoil into annual events, so many investors have learned to sit back and let it happen.”

The markets began to build in a so-called risk cushion well before the election was called, just as they did last year before the referendum on the Constitution. Like a firebreak in which a limited area is cleared or plowed to prevent a fire from sweeping through out of control, a cushion of higher interest rates and a lower dollar acts as a disincentive for investors to leave the market. Since July, the Canadian dollar has fallen two cents in value to about 76 cents (U.S.). During the same period, the bank rate has climbed more than half a percentage point to five per cent.

Last week, the stock market, which is not as immediately and directly connected to political issues as the highly interestsensitive bond and currency markets, plunged 170 points, or 4.2 per cent, in two days. A $14 drop in gold bullion prices, which directly reduced the value of the shares of Canadian gold mining companies trading on the exchange, started the sell-off. But the election may also have played a role, albeit a less direct one. “The market doesn’t like uncertainty,” said Fred Ketchen, director of equity trading at ScotiaMcLeod Inc. in Toronto. “With the election on, people are expecting uncertainty and that makes them nervous and makes them want to wait it out on the sidelines.” He added: “When you have a couple of days like we just had when some people wanted to sell, and others wanted to stay on the sidelines, then naturally the market goes down.”

On a broader scale, Ketchen blames the stock exchange’s poor showing since 1987 on Canada’s almost constant political turmoil over free trade, the Goods and Services Tax and the protracted constitutional debate. “That’s why the Toronto market was one of the last in the world to reach record highs after the 1987 crash,” he said. In fact, it was only two weeks ago that the Toronto Stock Exchange index of 300 companies surpassed its all-time record high of 4112.9, recorded in August, 1987. It hit a new high of 4143.74 on Sept. 1, six days before it plunged. By contrast, the New York Stock Exchange surpassed its 1987-high of 2722.42 in 1989 and went on to hit its all-time high of 3652.09 late last month.

Still, a sudden dramatic event in the campaign could trigger a sharp market move. “If everyone is planning for it and anticipating it, the markets usually don’t react too much,” said Bryan Griffiths, senior vice-president of treasury operations at the Royal Bank of Canada. “The thing that creates market turbulence is a surprise that no one expects— like a prime minister appearing on TV and tearing a document to shreds.” That, of course, is a reference to the referendum debate, when then-prime minister Brian Mulroney ripped a copy of a speech in half— after citing a Royal Bank study that put a price tag on Quebec’s separation for every Canadian family. Almost immediately, public support for the agreement began to wither under the perception that politicians and the corporate community had joined forces to force the agreement through. With the criticism the bank took for issuing that report still stinging, Griffiths wryly remarked: ‘There is always the danger that someone will open mouth and insert foot. The markets can never prepare for that one.” And that’s what makes elections exciting.

BRENDA DALGLISH